Will the Republicans Force the United States to Default in the Next Few Months ?

The Upcoming Debt Ceiling Fight

The United States has exceeded its debt limit and the limit has to be raised in the next couple of months to avoid defaulting on its debt. Indeed, some experts are saying that the debt limit has already been breached and the Treasury is resorting to extraordinary measures to keep the economy going. Further, the point needs to be understood that raising the debt limit means that the United States has the facility to fund what has already been spent and raising the debt limit does not mean that the country is engaging in more debt.

In other words, what politicians across the spectrum have to keep in mind is that the debt limit is all about repaying what is already spent and hence, it is not an indicator of how much the United States has to borrow in future. That is a separate issue altogether and the reason for discussing this aspect in detail is that the Republicans have been consistently insisting that the US cannot go on borrowing without cuts in spending.

Insistence on Spending Cuts to Cooperate on Raising the Debt Ceiling

To continue the last point made above, the Republican Party is stuck on the demand that in order for Congress and the Senate to increase the debt ceiling, there must be a corresponding agreement to cut spending on social and welfare related services. This means that the Republicans are tying the deal to increase the debt limit on the Obama administration agreeing to spending cuts. Without going into too much detail about how these spending cuts would impact the economy, it needs to be mentioned that spending cuts in welfare and social related schemes would hurt the poor and the needy more than they would hurt the rich and the privileged.

Considering the fact that the poor and the needy have already been hurt and impacted by the ongoing recession, it would be fair to say that such spending cuts would deal a double whammy to them and would leave them without any state guaranteed social services. The point here is that spending cuts can also be in the realm of defense and other areas where the US is already a profligate spender and hence, spending cuts can be actualized in those areas.

Worst Case Scenarios and Best Case Scenarios

The worst case scenario would be one where the US defaults on its debt which would lead to a catastrophic effect on the global financial system since the US is the world’s largest economy and the pivot on which the global economy rests. This means that all stakeholders have to realize that actualizing the agreement on the debt limit is in everybody’s interest and hence, they must sit down at the negotiating table and thrash out an agreement on raising the debt limit. The last time such an eventuality was contemplated which was in fall 2011; the US had to suffer a ratings downgrade because of the brinkmanship of the Republicans. Therefore, the worst-case scenario cannot be contemplated at all and so, the best-case scenario would be one where the Republicans take the fight till the last moment and then agree on raising the debt limit. Even this best-case scenario is dangerous because delaying the agreement till the last minute would spook the markets and cause the interest rates to rise, which would have knock on effects on all sectors of the economy. The point here is that the situation is such that both the worst-case scenario and the best-case scenario offer dangerous times for the US economy and this is the key point that is being made in this article.

Concluding Remarks

Finally, it is our recommendation that investors and professionals prepare themselves for all eventualities and take steps accordingly. The show of brinkmanship that is being played out in Washington makes for good theater but bad economics.


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Managerial Economics